The State of Cryptocurrency – Supply & Demand

Guest Post by Michael Frazis.

People can be relied on to disagree in two areas: politics and prices. In these two fields lies the most foolish behaviour of humankind.

The year 2017 may have been the year of turning real money into fake money. But it’s 2018 now, and the cryptocurrency market is unlikely to increase another thirty-three times this year – though that would be a sight indeed!

crypto market cap

This is a historic period in financial markets that will be written about for centuries.

The seven or so hundred billion dollars of crypto-value simply didn’t exist a few years ago. It’s all now in the hands of techno-enthusiasts, who are pouring it into new coins.

Attention is the true currency here, and coins that can build and maintain attention, no matter how ridiculous, are attracting enormous valuations. Holders of Dogecoin and Useless Ethereum Tokens will know what I’m talking about.

Buying and holding crypto still expose you to a rat’s nest of hackers, thieves, and criminal states. Exchanges have matured dramatically from the days of Mt Gox, and are less likely to take a look at their customer’s bitcoin and run off with it. They’re simply too profitable as honest businesses.

But given the increased sums, the stakes and temptations are higher. There are no guarantees and no chargebacks in this new world.

Meanwhile, the protocols are maturing. The rules are becoming clearer and even after a manic 2017, the real game has barely started: where people build game-changing businesses.

Crypto feels like the app store after the first or second iPhone. We all know that it will be big, with world-changing applications, but the damn things are just too slow right now.

A simple Cryptokitties app, where kitties breed and are bought and sold as collector’s items, reduced the Ethereum network to a crawl.

Eventually, the networks will speed up, and there are thoughtful entrepreneurs watching, studying and learning.

a breed able crypto kitty

A breedable cryptokitty, reminiscent of the Tamagotchi craze. $20 million has been spent on these – child’s play relative to the >US$100b global games market.

The conversations around tables in Asia, Africa, Europe and the Americas are rarely about apps.

Instead, the question on everyone’s lips is that never-ending riddle: where are prices going?

Seven hundred billion sounds large (editor note: prices have fallen ~$100 billion since this was written), but this is about equal to a leading US tech company. But given the amount of attention on the space, this order of magnitude actually seems about right.

The crypto market capitalisation is still small for an industry, and very small for an asset class.

Even in such a strange world, the usual clues of supply and demand are faithful friends, whom even crypto markets in the grip of the global zeitgeist must eventually obey.

When the tides of speculation recede, what demand will be left? And what supply?

What will happen when the cryptopreneurs try to turn their paper wealth into real money?

One approach would be to find use cases that are dramatically improved with crypto, that should maintain demand irrespective of which direction the animal spirits rush.

As a first run, here are five. And, they are enormous markets:

  1. Criminals
  2. Citizens in sketchy states
  3. Indeed, criminal states
  4. Venture capital
  5. A redesign of the entire app ecosystem.

Make a judgement call on each of these, and you can figure out whether the current $700 billion sounds high or low.

Criminals

Blockchain has triggered the world’s greatest crimewave. There are simply very few ways to steal tens or hundreds of millions of dollars (perhaps politics aside!)

If you were ‘hacked’ in 2008 it probably meant someone mucked around with your emails, and, depending on your personal tastes, caused mild to excruciating embarrassment.

Now, with such widespread crypto speculation, many home computers hold serious amounts of cryptocurrency.

I like to think there were people in the various global mafia suggesting years ago that money be laundered through crypto, have since been showered with the glory of filthy lucre.

In crime, as in business, the computer geeks are probably on top.

Even the criminal complex shows the democratising nature of crypto.

The mafia syndicates can be beaten at their own game by crypto-enthusiasts selling illicit drugs to anyone in the world, and efficiently laundering the proceeds, all based on anonymous but trusty reputation metrics.

silk road

The Silk Road, before the Dread Pirate Roberts, the founder, was arrested. Great story actually. There are now plenty of copycats.

Some might say that you’re safer dealing with an online dealer on approval ratings than a street hustler. But whether or not you agree, it’s unarguable that this was an early driver of crypto demand.

Be aware that bitcoin is pseudonymous, and transactions can be tracked. That is, after all, the whole point of a blockchain!

There are new coins, like Monero, that play specifically to the criminal use case. Worthy of note for a speculator.

Citizens in Sketchy States

From Sydney, where I’m currently writing, it’s hard to imagine money in a bank account vanishing.

But it happens all the time, even in Europe. Ask the Cypriots. Venezuelans, Argentinians, various African countries. All have effective state theft in living memory.

Perhaps it’s more terrifying to live in a state where the rule of law is strong, but enforcement is political.

Selective ‘corruption’ purges in Russia, China and Saudi Arabia put everyone at risk. Even those at the top can never be safe from their successors.

I doubt any of those accused would have completely escaped the net with crypto, but they would have been able to stash away significant amounts of value for their families.

There are pensive viewers, watching, nurturing their fortunes and thinking about their families, all around the world.

Criminal States Themselves

North Korea can now convert electricity into serious amounts of globally usable currency, as can any other intelligence organisation that cares to secretly fund nefarious actors.

Forget sanctions, now electricity equals global spending power.

This is not exactly a small market. No matter what the bitcoin price does, you can be sure that the transaction value undertaken by these organisations will remain significant, and increase as the intrinsic advantages of crypto become more and more apparent.

I wonder if the North Korean threat was behind South Korea’s recent banning of cryptocurrency.

It seems they’re behind a lot of the hacks.

Venture Capital

Finally, on to something more positive!

Kickstarter – founded in the same year as bitcoin – revolutionised the new ventures, allowing people to sell their products before they were built, and use the actual proceeds to build them.

Incredibly democratising, and you have to be quite sour to find a downside. Perhaps US$2 billion has been funnelled through Kickstarter to new businesses.

But Kickstarter and its peers have drawbacks. Founders can’t offer real upside to their early backers, and buyers can’t trade their claims.

Most importantly, Kickstarter determines access and sets the rules.

Enter ICOs, Initial Coin Offerings, where users deposit bitcoin or Ethereum (usually) and receive a new coin.

Those running ICOs can set the rules. They can reward early backers however they like, and punters are free to trade their claims at any time.

This was simply not possible before.

Kickstarter’s sweet spot is in small products: bags, fashion items, films and games.

For more mature companies, that need tens or hundreds of millions, the game has completely changed, for the better.

Previously venture capital tended to flow to founders at famous universities in very small corners of the world.

For those putting in money, the investments are highly illiquid, and capital is locked up for up to a decade, or more. Successful investments are very slowly realised.

This is bad, as realised profits are typically recycled into the next round of startups, and it’s those early stages where capital can be so beneficial to the enterprise’s success, and their ability to hire and boost the economy.

Compared to crypto: funding can and does come from all over the world, in tens or hundreds of millions of dollars. The investments are immediately tradable, and open to everyone.

Many of us were effectively addicted to Airbnb and Uber years ago, but despite our conviction in the success of those companies, we never had the opportunity to invest.

In the future crypto world, that won’t be the case.

And, in fact, companies like Airbnb and Uber could be very effectively disrupted by the power of crypto.

Which Brings Us to Apps

Most situations involving private information that needs to be selectively verified, should probably be on a blockchain.

Medical records, criminal records, university transcripts … even now sexual consent.

These all have something in common: critical information that needs to be both private, and verifiably true in particular situations.

But the real power of crypto is the way it can provide value to early users.

PayPal famously gave $10 to every new user. A very straightforward approach to customer acquisition!

Uber gave away free vouchers, and many startups try to find ways to do the same.

This is simply incomparable to the flexibility of crypto.

Now, early users of an app can accumulate, from a fixed supply, currency that can be used in that app.

If the app takes off, the restriction on supply ensures rich rewards for every early backer, not to mention the founders.

In fact, this is enough to compensate in its own right.

Uber currently charges 25%. Why doesn’t someone set an equivalent app where the driver keeps 99% of the value?

The founders can build the product off transaction fees, and the currency they set aside for themselves in the ICO. There are many apps that can be disrupted in similar ways.

Ratings systems revolutionised the internet. They drove Amazon’s success, and allowed the efficient success of anonymous websites stocked entirely with criminals (and the odd FBI agent).

Crypto could allow a verifiable identity that builds ‘trust’. As you go through your day, transacting honestly, hiring car rides, bicycles, rooms and so on, you could build up reputation in a completely verifiable way.

This alone is extremely valuable. Think of the value of Alibaba and friend’s credit rating system in China.

The point is that you, the user, can selectively decrypt your identity and verification. Unlike a pre-crypto attempt at this, no one can see it unless you unlock it, and because it’s on the blockchain that everyone can see and verify for themselves, you can guarantee it’s you.

Ok, But What About Supply?

I’ve kept quiet on this, mostly as I got this part of the equation wrong in 2017. I thought that a wave of ICO supply would suck the capital out of the market.

Having studied the tech boom of the 1990s, it’s striking how the peak of IPOs, the equity market equivalent of ICOs, sucked out cash from the market right at the top. Investors sold shares and put the cash in new firms, where it was taken and spent by the founders. Perhaps causing the fall in prices, which lead to further selling.

The same dynamic seemed to be building in ICOs.

I made a mistake, however. It turns out that, in the short and mid-term, ICOs actually increase demand for crypto.

You need to deposit bitcoin or Ethereum, so if you see an ICO you like, you’ll have to pay up. The issuer of the new coin generally holds the bitcoin/Ethereum for quite some time, thus locking up that supply.

This is very different to the stock market, where a hyped company can create and sell stock in themselves to create cash.

This also gives a mechanism as to how many of these coins may finally come undone.

Please have no illusions – I love the space, but in my honest opinion, the vast majority of ICOs, are going to zero.

This isn’t a profound statement – most business, go to zero.

Remember that while the supply of each coin is highly restricted, the market is not.

People are building supply restrictions – with the intention of maintaining price increases – Into the functioning of their coins.

Personally, I wish people would worry less about making their coins go up in value, and more about building businesses that really take advantage of the power of crypto.

The amount of money that can be made in business puts even the riches available in crypto to shame.

So how can a cryptocurrency be worth anything at all? If there was a blow up, what would it look like and what should you do? Isn’t the whole thing a massive waste of electricity? And where should you actually invest? Subscribe below for Part II.

About the Author

Michael Frazis is the founder of Frazis Capital Partners, a boutique global investment fund. He owns small amounts of cryptocurrency personally. If you’d like to keep up to date with his ramblings and investment tips you can subscribe to his email newsletter here or follow him on his blog

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